Sears Holdings – Unsecured Creditors Demand “Full Investigation” of Insider Transactions, with Focus on Edward Lampert, ESL, Seritage and Fairholm

November 6, 2018 – Sears Holdings’ Official Committee of Unsecured Creditors requested Court approval to conduct an examination of, and seek discovery and investigation from, the Debtors, their advisors and controlling shareholders, and other third parties on certain “insider problematic transactions” by and between the Debtors and ESL Investments, Inc., Seritage Growth Properties, Fairholm Capital Management & certain other smaller entities [Docket No. 484]. 

The motion explains, “By this Motion, the Committee seeks to take discovery, of the Debtors’ controlling shareholder’s ESL Investments, Inc. (together with its affiliates, “ESL”), Edward Lampert (“Lampert”), the Company’s Chairman and former CEO, who is also the current Chairman and CEO of ESL, and certain additional parties in connection with a series of prepetition transactions that the Committee (and the Debtors) believe may give rise to material claims and causes of action in favor of the Debtors’ estates. Indeed, the Debtors made clear on the first day of these cases that potential causes of action arising from affiliate transactions involving ESL and Lampert consummated prior to the Petition Date (as defined below) may exist….Based on its limited investigation in the short time since its formation, the Committee is convinced that there exist potential estate claims and causes of action (collectively ‘Claims’) arising from the Debtors’ various attempts to finance the Company’s operations, often involving related-party transactions with controlling shareholders ESL and Lampert. Some of these transactions also involved Fairholme Capital Management LLC (along with its affiliates, “Fairholme”), another significant stockholder of the Company, and other third parties. The circumstances surrounding the various transactions raise the possibility that ESL and other insiders may have exercised undue influence to siphon value away from the Company on favorable terms. In addition, these parties may have used their insider status to obtain an ever-increasing percentage of the Debtors’ senior debt, positioning them to exert undue influence over, and obtain beneficial positions in connection with, the events leading up to, and the trajectory of, these chapter 11 cases. Indeed, through an escalating series of transactions in the years and months leading up to the Petition Date, ESL has managed to obtain $2.6 billion, or 46%, of the Debtors’ funded prepetition debt, including approximately 73% of the second lien debt.

 

Sears Holdings contributed 31 properties to the Joint Ventures (JV’s) in exchange for 50% interest in the JVs and $429 million in cash. In July 2015, Sears Holdings formed a new, publicly traded real estate investment trust, Seritage Growth Properties, and an affiliated operating partnership, Seritage Growth Properties, LP (collectively, ‘Seritage’). Sears Holdings then entered into a sale-leaseback transaction with Seritage: First, it sold 235 properties to Seritage along with its 50% interest in the JVs for aggregate gross proceeds of $2.7 billion. Following the sale, Sears Holdings entered into lease agreements (the ‘Master Leases’) with Seritage and the JVs to lease 255 of the properties, with the remaining properties being leased by Seritage to third parties. Under the Master Leases, Seritage and the JVs had the right to recapture 50-100% of the space within certain stores, meaning they could literally evict Sears and re-let the space to tenants capable of paying higher rents. Several aspects of the Seritage Transaction raise concerns for the Committee. To begin, the Seritage Transaction bears the hallmarks of a transaction to benefit insiders ESL and Fairholme.  To fund its acquisition of the properties, Seritage entered into agreements with both ESL and Fairholme for certain private placements in connection with its initial rights offering….In exchange for the sale of Sears Hometown and Outlet (‘SHO’) common stock, Sears Holdings received $346.5 million in cash as well as a $100 million dividend from SHO prior to the separation, resulting in aggregate gross proceeds of $446.5 million. Following the spinoff, ESL and Lampert owned a majority of both Sears Holdings and SHO. Because of the separation, SHO, at the time a profitable company, was now isolated from Sears Holdings, which could no longer access SHO’s assets or cash flow. The Committee believes that the market value of SHO at the time of the SHO Transactions, evidenced by its trading price immediately after the closing of the rights offering, was significantly higher than the value received by Sears Holdings.

 

In sum, the Insider Transactions, and various other potentially problematic transactions, left the Debtors heavily levered, with far more debt (and substantially fewer valuable assets, particularly their real estate assets) than prior to such transactions.  All or substantially all of these transactions appear to have been undertaken at a time when the subject entities were insolvent or rendered insolvent thereby.  The circumstances surrounding the Insider Transactions also suggest that the Debtors received significantly less than reasonably equivalent value for certain of their profitable and most highly valued assets and were left with far fewer unencumbered assets.  In the Committee’s view, these Insider Transactions (and others) warrant a full investigation to ensure that the Debtors pursue all available Claims for the benefit of all unsecured creditors and ensure that ESL and Lampert are not provided with unfair leverage in their effort to acquire the Company’s valuable assets at deflated prices or through an inappropriate credit bid of avoidable debt. That investigation must proceed swiftly in light of the critical timing considerations the Company faces.”